MPs find failures everywhere and call for new Bank troubleshooter

A crack team of supervisors who would be based in the Bank of England holds the key to preventing another Northern Rock-style banking collapse, according to a hard-hitting report by a powerful committee of MPs.

The new grouping, under the control of a central bank deputy governor, should take charge when any bank or building society is found to be in financial difficulties, the MPs said.

The recommendation of an enhanced role for the Bank comes in a Treasury select committee report. The report puts most of the blame for the first run on a British bank for 140 years on the Northern Rock board and points to serious flaws in the tripartite system of regulation.

In contrast to the government, which has recommended the Financial Services Authority be handed extra powers when banks get into trouble, the committee believes the Bank emerges from the debacle with a less sullied reputation and would prove a safer pair of hands.

The central bank still comes under fire in the 180-page report, however. In particular, the governor Mervyn King (below) is criticised for his refusal to lend Northern Rock funds at a time when other central banks were taking a more active role in protecting institutions hit by the credit crunch. Sir John Gieve, the deputy governor responsible for financial stability, is singled out as a weak link in the chain of command and slow to react to prevent the run on the Newcastle-based bank.

MPs also pin the blame on Northern Rock's non-executive directors Derek Wanless, the former NatWest boss, and Sir Ian Gibson along with the former chairman Matt Ridley, for their inability to rein in the excesses of the bank's executive directors and the chief executive, Adam Applegarth, in particular.

Wanless, the former head of the bank's risk committee, Gibson and Ridley, allowed the bank to become an "outlier" in the industry with probably the most exposure to international money markets of any European bank.

However, the report reserves its most intense criticism for the FSA, which MPs said had failed to tackle the Northern Rock board and take decisive action to reduce the risk that the looming credit crunch would cripple its financing.

The all-party group on the Treasury select committee said the FSA "failed to tackle the fundamental weakness in [Northern Rock's] funding model and did nothing to prevent the problems that came to the fore from August 2007 onwards. We regard this as a substantial failure of regulation."

The committee chairman, John McFall MP, said: "Our report has been unanimously agreed. It recommends a radical shake-up at both the Bank of England and the FSA. Both have been found wanting with regard to financial stability.

"Accordingly the committee has identified a need for a new office of deputy governor of the Bank of England and head of financial stability. This individual should be one of the principal channels of advice to the Chancellor of the Exchequer on financial stability.

"If the government wants a fair wind for their reforms to the tripartite arrangements in parliament, they must take seriously the cross-party recommendations in this report, which represent the will of parliament," he said.

Among the other remedies put forward by the committee were:

· An early-warning system to allow authorities to monitor banks before they need the lender-of-last-resort facility;

· In the event of a collapse, a "bridge bank" to take control and ring-fence depositors' funds;

· An industry protection scheme applying to all banks and building societies to be pre-funded by the industry;

· Government to assume control of banks that need to be rescued with taxpayers' cash;

· Banks to alert customers to how much of their deposits are not covered by the insurance scheme;

· Auditor conflicts of interests to be addressed by accounting bodies.

Whoever assumed the deputy governor's enhanced role would have a direct link to the chancellor once a bank indicated it was in trouble. It was unclear from the report how the new post would relate to the governor of the central bank and the chairman of the FSA, who under the current system share equal responsibility for handling a crisis.

McFall said the government prevented a potential collapse in the banking industry when it sanctioned support for Northern Rock in September. But regulators should take a harder line in future. "Banks should be allowed to fail to ensure market discipline, but only in an orderly manner," he said. "The recommendations in our report provide bank customers with new protections in the form of a deposit protection fund and a special resolution regime for banks. Customers in a failing bank must be assured their guaranteed deposits are readily available. With measures such as these, there should be no reason for the queues in the streets that we witnessed in September to form ever again."

Explainer

New office

The Old Lady's eyes and ears

An "office of the deputy governor of the Bank of England" would bypass the Financial Services Authority in a crisis and report directly to the chancellor. This is the main recommendation put forward by the treasury select committee. A team drawn from the Bank of England, the Treasury and the Financial Services Authority would sit inside the offices on Threadneedle Street watching out for the next banking collapse.

Who would join this crack team is unclear. And why there would be a more harmonious relationship between this group and the supervisors at the FSA is not explained. Nor is the relationship between the governor and deputy governor outlined.

There were rumblings in the City last night that adopting the committee's plan would introduce a fourth "player" along with the chancellor, the governor and the FSA chairman. Would the new group spend its time analysing the industry or questioning banks about their business plans? Staff that analyse don't tend to be the type to kick down doors, as the FSA has discovered. The Tories welcomed the plans, but the Liberal Democrats said more fundamental solutions were needed. To prevent another Northern Rock-type crisis, Vince Cable, the Lib Dem spokesman, called for "more active controls of bank lending".

· This article was amended on Tuesday January 29 2008. Vince Cable, rather than Caborn as we said above, speaks for the Liberal Democrats on finance. This has been corrected.